^{Originally published in The Australian Financial Review on 6 July 2025. See the original article or download the article.}

It’s fair to say the world is grappling with a confluence of issues, many with significant long-term ramifications and large unknowns.

From intensifying geopolitical tensions in the Middle East to a barrage of US policy shifts with direct impacts on global trade, inflation, and growth, uncertainty is undeniably elevated. And yet, equity markets in both the US and Australia are testing all-time highs.

Given markets are typically allergic to uncertainty, this apparent contradiction deserves closer examination.

The “liberation day” US tariffs in April initially rattled investors, triggering concerns about a recession and renewed inflationary pressures. But just weeks later, those fears seem to have faded.

The S&P 500 has staged a V-shaped rebound, and the ASX 200 has surged to
record levels. How has this happened?

In Australia, part of the rally can be explained by increased inflows from offshore investors looking for exposure outside the US. Australia stands out as a relatively safe, stable economy with low direct exposure to global trade tensions and an attractive valuation given the current Australian dollar/US
dollar exchange rate.

Index-level buying, particularly from passive strategies, has driven up heavyweight names such as Commonwealth Bank – despite lofty valuations – simply because they dominate the benchmark.

Factor analysis confirms that in Australia, price momentum, earnings, and quality have been the key drivers of performance this year. Valuation, it seems, has been relegated to the back seat.

The US rebound is harder to rationalise. On fundamentals alone, tariffs are likely to dent growth and stoke inflation, yet the market is now higher than it was pre-announcement.

Part of the explanation lies in the better-than-feared first quarter earnings season, which reaffirmed the resilience of the US consumer and corporate sector. But these are, by nature, backward-looking indicators.

A more forward-looking driver may be the deepening conviction around the transformative potential of artificial intelligence. AI was a dominant theme during earnings season, not just in tech, but increasingly across retail, financials, healthcare and travel.

Chief executives spoke with growing confidence about using AI not only to cut costs but to unlock innovation and efficiency gains across their businesses. Used effectively, AI could shift the productivity frontier.

By reducing the amount of time people spend on repetitive, low-value tasks it opens the door for more strategic, creative and value-accretive work. If this plays out at scale, it could drive a structural uplift in gross domestic product growth over the medium term.

Complementing this optimism is a renewed policy focus in the US on deregulation, re-shoring of manufacturing, and faster approvals for business formation and infrastructure.

If executed well, admittedly a big if, we believe these policies could set the stage for a new investment cycle. Add in a few rate cuts later this year, and the market’s optimistic tilt starts to make more sense.

Tread with caution

But let’s not get too carried away. These are still possibilities, not guarantees. The risks are very real: sticky inflation, policy missteps, fragile global growth, and renewed geopolitical flare-ups could all derail the current rally. The world remains uncertain, and market reactions can shift quickly.

That said, one constant I’ve observed in more than two decades of market watching is this: never underestimate American optimism. It’s a deep-rooted trait, powered by a culture of innovation, entrepreneurialism, and a collective belief that progress will prevail.

This optimism can become self-fulfilling, particularly when supported by capital flows, structural trends like AI, and a still-healthy consumer.

So what does this mean for Australian investors?

First, it’s a reminder that valuation alone isn’t enough to drive returns in the short term. Momentum, earnings, and thematics are dominating the current landscape. Second, Australia remains an attractive destination for global capital, and that could continue to support index-heavy names.

But investors should tread with caution. Just as the market has powered through a wall of worry, it could just as easily be knocked off course by an unexpected turn. Staying nimble, diversified, and anchored in fundamentals will be key.

Ultimately, uncertainty remains high, from geopolitical tensions to policy risks, but markets may be looking through the noise to longer-term structural shifts. AI has the potential to drive real productivity gains, particularly if supported by investment and sensible policy.

For investors, this means staying selective, focusing on quality companies with strong balance sheets, earnings momentum, and exposure to innovation. While caution is warranted, especially with valuations stretched in parts of the market, there are also emerging opportunities that could benefit from the next phase of economic transformation.

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